How do we manage the pension freedoms?
There are people who benefit from the pension freedoms and there are those we should be worried about, says Peter Hopkins, technical resources director, AJ Bell
The latest batch of pension freedoms figures released by the Government once again spurred debate about whether the reforms are producing good outcomes for savers.
More than £16billion has been flexibly accessed since the freedoms launched in April 2015, although the average quarterly withdrawal in Q4 2017 hit a record low of £7,596 – more than £2,000 lower than the figure recorded in the same period a year earlier.
The big question is: ‘Are savers generally using the freedoms in a sensible, sustainable way?’
The truth is without knowing the individual circumstances of the people accessing their retirement funds, we can’t be sure whether withdrawals are being managed sustainably.
But, in this brave new world, what exactly is ‘sustainably’? It’s worth remembering that the origins of pensions flexibility are not in former Chancellor George Osborne’s 2014 Budget but span way back to 1995, when income drawdown was first created.
For those with a sum of cash in a pension scheme that was the point at which you could access your tax-free lump sum and take income from the fund without pooling investment and mortality risk.
Those who unfortunately died before 75 would have money to pass on and those who reached 75 would buy an annuity. Sustainability in that world meant not running out of money before age 75 and turning whatever was left into a guaranteed income after that point.
There were various interventions from 1995 onwards as successive Governments wrestled with the sustainability conundrum. This led to various edits of review periods, GAD limits and accessibility after the age of 75 – before the rule book was ripped up by the introduction of the pension freedoms almost three years ago.
Rate of withdrawal
We now live in a world where anyone can, if they choose, go it alone – with no guidance or nudge on how to do this. There is no single, sustainable rate of withdrawal and nearly all people will therefore either run out of money or be left on death with a sum to pass on. The case of the demise of the consumer coinciding with the final payment being taken is going to be very rare.
Many savers will use the freedoms rationally, hopefully with the help of a regulated financial adviser, to build a retirement income plan that works for them. This might involve spending their entire defined contribution (DC) pension early before living on the state pension and any defined benefit entitlements thereafter, or leaving as much of their DC pot untouched as possible in order to pass it on to loved ones after death.
For these people, I am not too worried as they are making rational choices based on their own circumstances.
I worry more for those who’ve got better things to do than to think about this sort of stuff. They’re not engaging with the thought process. They drift into retirement and drift into pension freedoms, withdrawing money without even thinking about what they will do if it runs out.
Perhaps providers should offer a default fund with a default withdrawal rate? But what happens if it turns out to be too aggressive and at age 83 people are shocked when their retirement pot has been exhausted?
Whilst a sustainable rate for the masses is currently unknown, I would fret more if one was to be suggested. In order to address sustainability concerns policymakers should focus on bridging the engagement gap that exists for those entering retirement.
Those that drifted before 2015 got an annuity. We need to start a serious conversation not just about what happens to those who drift into retirement today, but how we can ensure more people play an active part in their retirement outcomes.